Brian has been kind enough to offer his current thoughts on gold to RiskReversal. Personally, I don’t have a strong view on gold, silver, or precious metals miners at the moment. I was stopped out of my GG long position for a profit earlier this week, and the overall underperformance of silver has me concerned about the precious metals complex as a whole. Regardless, Brian’s analysis below offers some interesting historical comparisons and leads to a thoughtful discussion about the potential driver of gold going forward. – Enis
Can Gold Rally With a Strong Dollar?
Like many myths on Wall Street there is an entrenched (and incorrect) view that gold can only rally when the US dollar is weak. The rationale is that gold is priced in US dollars, therefore when buying gold you are implicitly saying that you believe the price of gold will rise and the dollar will fall. In other words, you are trading your US dollars for gold in hopes of a higher return. While this makes intuitive sense, it is just not true all the time.
The following chart is the rolling 1 year correlation between spot gold and the US dollar index. As a refresher, when the correlation is below zero it means when the dollar falls the price of gold rises. As the chart illustrates, the price of gold and the US dollar do not always trade in opposite directions.
In fact there have been at least four periods since 1978 when the price of gold and the US dollar were positively correlated – 1983, 1994, 2006 and 2011. What do each of these periods have in common? Rising interest rates.
The next chart shows the YoY percentage change in interest rates for the 5 year US Treasury note. The chart is designed to illustrate periods of rising or falling rates – anything below zero indicates falling rates, while above zero indicates rising rates.
Looking at the periods of 1983, 1994, 2006, and 2011 there are large changes in interest rates. This not to say there were interest rate spikes or extremely high rates, just that there was a change from falling rates to rising rates. Now take a look at the percentage change on spot gold since 1978.
Once again this chart is designed to show periods of rising and falling prices. Since 1978 the largest gains for gold came during 1983, 1993, 2006 and 2011. During these periods both the US dollar climbed and the price of gold increased. This data yields a few juicy tidbits that we can use in today’s market: 1) interest rates and gold are positively correlated and 2) gold and the dollar can rise together. Taken altogether, if you are bullish on the US dollar and think that interest rates are going to rise then you should be buying gold.
Disclosure: BK is long gold and silver